Experimental feature

Listen to this article

Experimental feature

Tesco’s admission of an overstatement of profit by at least £260m plunged Britain’s biggest retailer into the most serious crisis in its almost 100-year history. But it was also a salutary lesson in managing risk — particularly in a company that had grown to dominate its markets.

The debacle sparked a series of inquiries, including one by the Serious Fraud Office, and a number of lawsuits against the company.

Insiders say the seeds of the crisis were sown in the final years of the reign of Sir Terry Leahy, the Liverpool-born marketing manager who rose to become chief executive. In his 14 years at the helm of Tesco, he transformed a struggling domestic grocer to a powerful international brand.

Former Tesco boss Sir Terry Leahy © Bloomberg

But, they suggest, there was a growing schism between the performance of the company and the health of Tesco — financially and culturally.

In the mid-1990s, Tesco overtook market leader and rival J Sainsbury. Richard Hyman, the independent retail analyst, says part of Tesco’s success was that it still acted like the underdog.

“Even when Tesco was the number one, everyone in food retailing, including Tesco, thought Sainsbury was the better retailer,” he says.

“Far from being negative, it was a positive, because a central part of Tesco’s culture was being more thrusting, more driven and more ambitious and self-challenging. However we do it now, we can do it better.”

But, over the following years, the Tesco juggernaut rolled into everything, from clothing, telecoms and banking to garden centres.

In 2009, Tesco announced record annual profits of more than £3bn.

The most audacious move came in 2006, when it announced it would open a chain of stores in the US. A year later, Sir Terry opened Fresh & Easy, a small store that was part neighbourhood supermarket, part discount chain and part convenience store.

Tesco cast aside many of the strategies previously used to manage the risks associated with new ventures. Rather than acquiring a business, as it had in South Korea, it started the operation from scratch. And it ignored local tastes, despite carrying out extensive research. It stocked Fresh & Easy branded products as opposed to the big, well-known consumer brands desired by American shoppers. It also stocked few frozen lines and pre-packaged fruit and vegetables, even though US shoppers like to touch and feel their produce.

As Tesco grappled with the US, conditions in its home market deteriorated.

Philip Clarke, the Tesco lifer who had succeeded Sir Terry in March 2011, was facing twin threats — from Waitrose at the top of the market and German discounters Aldi and Lidl at the bottom. Despite this, Mr Clarke sought to continue to maintain Tesco’s profits.

The exact cause of the profit overstatement is still under investigation, including by the SFO. What is clear, however, is that Mr Clarke and the senior UK team were under immense pressure to deliver the results demanded by London’s financial investors.

Tesco said the profit overstatement was caused by counting the money it received from suppliers too early. Tesco receives this so-called “commercial income” from suppliers for selling more of their goods or to pay for special offers and promotions.

One symptom of the growing reliance on suppliers is that the number of products sold increased by 30 per cent under Mr Clarke as Tesco received fees for stocking more products.

Tesco has since cut the number of product lines by 15 per cent and overhauled the way it deals with suppliers.

It is simplifying deals with suppliers, by agreeing a price upfront and sticking to it. In the past it would settle on a price but request myriad other payments to get a better deal. It is also simplifying its standard payment times for specific product categories.

According to Mr Hyman, one of the lessons from the Tesco debacle is that slavishly striving to meet one target can lead to unintended consequences.

“This is about leadership,” he says, “If you foster a culture where you are driven to delivering certain performance indicators it is going to lead to disaster. It is just a matter of time.”

It is a point recently accepted by Dave Lewis, who took on the role as Tesco’s would-be rescuer with his appointment as chief executive last September.

“Commercial income driven by a profit focus had clouded our purpose,” Mr Lewis said.

Samuel Johar, chairman of headhunter Buchanan Harvey, says the tone and culture of an organisation is set at the top and, to mitigate risk, chief executives must lead staff in the right direction.

“If the tone set is a bad one, then this can lead to all sorts of problems lower down,” Mr Johar says.

Get alerts on Fund management when a new story is published

Copyright The Financial Times Limited 2019. All rights reserved.

Follow the topics in this article